Lingering Fears Push Spanish Short-Term Borrowing Costs Up

LONDON — Spain’s cost of borrowing continued its rise into unsustainable territory Tuesday, reflecting heightened fears that the country would eventually need a bailout that Europe might not be able to afford.

In an auction of short-term debt, the Spanish Treasury had to pay interest of 5.074 percent to attract buyers. That compared with a yield of 2.985 percent, itself a lofty level, only a month earlier. And it came after Spain’s 10-year bond on Monday reached its highest interest rate since the creation of the euro currency union.

“The market is very uncertain that the euro will survive and, if that is the case, you don’t touch this debt with a barge pole,” said Christel Aranda-Hassel, senior European economist in London for Credit Suisse. “You need to break this fear that the euro is on the verge of breakup,” she said. “The pressure is definitely on the euro area member states to figure out how they break the deadlock.”

Spain plans to test the market again on Thursday, with an auction of longer-term bonds.

The government has some flexibility in the amount of debt it needs to sell now, because through previous sales it has already covered about three-fifths of its borrowing needs for the full year. Spain’s Treasury accelerated its scheduled bond sales in the first quarter to take advantage of long-term loans provided by the European Central Bank to banks that bought hefty amounts of domestic debt.

But the rise in borrowing costs has raised the possibility that the Spanish government could need a full rescue package of the type other troubled euro bloc countries have sought — and that Spain has tried desperately to avoid.

“By issuing debt at such an interest rate, Spain is putting at stake a sovereign bailout in the coming months,” said Fernando Ballabriga, an economics professor at the Esade business school in Barcelona.

Spain has moved back to center stage in the euro crisis after elections Sunday in Greece brought to power a center-right political party that is working to form a governing coalition and remain in the euro.

The Greek vote was welcomed in Madrid on Monday by Prime Minister Mariano Rajoy as “very good news for Greece, for the European Union, for the euro and also for Spain.”

But while the first-place finish of the Greek party New Democracy removed for the moment the immediate threat of dissolution of the currency zone, it did not address the fundamental problems facing Spain and other members of the euro zone.

Spain’s request this month for a €100 billion, or $127 billion, bailout for its banks left financial markets unimpressed, partly because the move will add to the country’s debt burden. That bailout became necessary as Spain’s deepening recession raised the level of mortgage defaults and pushed the proportion of bad loans held by banks to their highest level in 16 years.

Market confidence in Spain’s bank rescue deal has also been undermined by the fact that its exact terms are yet to be negotiated.

“By admitting that it is no longer capable of propping up its banks, the Rajoy government has sent a message to the markets that the sovereign is in need of external support too,” Nicholas Spiro, managing director of Spiro Sovereign Strategy, a consulting firm in London that assesses sovereign debt risk, wrote in a note Monday.

“In the realm of investor perceptions, Spain has crossed the Rubicon from solvency to insolvency,” he said. “The markets are treating Spain’s bank-focused bailout as a pregnancy: there’s no such thing as a partial one.”

On Tuesday, Spain sold €2.4 billion of 12-month bills at the 5.074 percent rate. It also sold €640 million of 18-month debt with a yield of 5.107, compared with 3.302 percent last month.

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Madrid is also hoping to sell up to €2 billion in longer-term government securities on Thursday.

The yield on Spanish 10-year bonds, considered the benchmark for borrowing costs, slipped to 6.955 percent at the end of the European trading day Tuesday. On Monday, that yield rose as high as 7.2 percent, a record since the inception of the euro and a level seen by many — including the country’s economy minister, Luis de Guindos — as unsustainable in the long term.

Investors say that with each succeeding auction, foreigners are buying less of Spain’s government debt while its troubled domestic banks are buying more, a trend that will continue if worries build that at some point foreigners holding Spanish bonds may be required to take a loss.

They note, too, that Spanish debt officials have not been frequently seen making the case that outsiders should buy their bonds.

At an investor conference in London hosted Tuesday by Euromoney, debt management officials from Italy, France and the Netherlands were talking up their country’s bonds. But the country most in need of a bit of outside buying support — Spain — was nowhere to be seen.

Still, investors appeared more optimistic Tuesday, as major European stock indexes rose broadly. The Euro Stoxx 50 index of euro zone blue chips gained nearly 2 percent, and the FTSE 100 in London added 1.7 percent. The DAX in Frankfurt rose 1.8 percent and the IBEX in Madrid jumped 2.7 percent.

In the United States, stocks were rising in afternoon trading on hopes that the U.S. Federal Reserve, beginning a two-day policy meeting, might agree on some form of financial stimulus.

The euro was up 0.9 percent, at $1.2694.

After the June 9 European rescue deal for Spanish banks, Mr. Rajoy had initially argued that Spain had secured highly favorable terms, insisting that the deal should not be compared with previous euro zone bailouts and that it would not affect the country’s public finances.

Since then, however, Mr. Rajoy has had to change his stance, as Spain’s borrowing costs have spiked again amid concerns about how the European emergency lending would affect the country’s already rising debt.

Separately, Moody’s Investors Service, the credit ratings agency, cut Spain’s rating last Wednesday by three notches, bringing it close to speculative, or junk, status, also citing concerns over Spain’s debt.

As a result, Mr. Rajoy has been trying, so far unsuccessfully, to persuade his European counterparts to agree that the rescue financing will be paid directly to Spanish banks, so as not to affect Madrid’s debt. The tussling over the terms of the bank rescue has raised concerns among investors that Spain would eventually need a broader, and significantly larger, sovereign debt bailout.

The worries have also been compounded by concerns about the size of the bank rescue. While Madrid initially suggested that it would not require the full €100 billion offered by Europe, it is awaiting the results of audit stress tests by two consulting firms, due on Thursday.

Meanwhile, four leading accounting firms are examining the 14 largest Spanish banks. Their findings are scheduled to be released by July 31, but could be delayed by a few months to give them more time to comb through the loan books of the banks.